Viewers Stream to Netflix

By

Amol Sharma and

Nathalie Tadena

Updated April 23, 2013 3:54 a.m. ET

Netflix Inc. reported stronger-than-expected U.S. streaming-subscriber growth for the first quarter and said it is getting more selective about the content it acquires in an increasingly competitive TV-programming market.

Shares of Netflix soared 24% in after-hours trading. The company also reported a small profit compared with a loss a year earlier, as well as a strong reception for "House of Cards," its high-profile original series which debuted in the quarter.

Netflix now is nearly on par with Time Warner Inc.'s HBO premium cable channel in terms of paying customers. HBO had 28.7 million paid U.S. subscribers at the end of the year, according to SNL Kagan, while Netflix's paid streaming subscribers at the end of March totaled 27.91 million. The company ended the quarter with 29.2 million U.S. streaming video subscribers, including those with free promotions, beating Wall Street's expectations.

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Profit for the quarter totaled $2.7 million, or five cents a share, compared with a loss of $4.6 million, or eight cents a share, in the year-earlier period. Revenue grew 18% to $1.02 billion. Operating profit margin in the U.S. streaming business widened to 20.6% from 19.2%.

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Kevin Spacey starred in Netflix's 'House of Cards

In after-hours trading on the Nasdaq, Netflix shares rose $42.73 to $217.10, its highest point since September 2011. The stock move suggests that investors are regaining confidence in the company after a pricing change in 2011 triggered a selloff that sent the stock from a high of nearly $300 to a low of $53.80 last September. The stock is up 88% year-to-date.

Netflix, which sells $7.99 monthly subscriptions, had negative free cash flow of $42 million in the quarter, a slight improvement over the fourth quarter, largely because of high content-acquisition costs. That situation underscores the problem of rising content costs.

Netflix has $5.7 billion in long-term content commitments. Helping fuel content costs is the company's plunge into original programming, highlighted by "House of Cards," a Washington political drama that debuted in February. Netflix will spend about $100 million on the show, including a second, yet-to-be-aired season. The company didn't disclose viewership statistics for the show, but in its quarterly letter to shareholders said the launch "provided a halo effect on our entire service."

Some analysts had said there was a risk that users could sign up for Netflix's free monthly trial, watch "House of Cards," and then cancel their services. But the company said fewer than 8,000 people engaged in that "free-trial gaming" out of the millions of free trials in the quarter.

It wasn't clear precisely how much credit "House of Cards" deserves for the brisk subscriber additions. "What we've seen with House of Cards is a nice impact but a gentle impact," Netflix Chief Executive Reed Hastings said on a conference call Monday evening.

In an interview later, Mr. Hastings said there wasn't an "overnight spike" in users from 'House of Cards' but rather a gradual impact. "It's a nice long-term tailwind," he said

Netflix hopes such original content will lure in subscribers and further differentiate it from competitors, including Amazon Inc. and Hulu, as well as premium TV channels like HBO and Showtime. Another original series, supernatural thriller "Hemlock Grove," launched Friday. And a new season of cult comedy hit "Arrested Development" will be released next month.

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Still, Amazon, in particular, has become more aggressive at licensing shows from Hollywood studios and in developing its own original series. Mr. Hastings told analysts that aggressive bidding for programming rights by Amazon and Hulu in the past year has driven up the cost of content licensing deals.

"That's made content providers happier and the prices higher than they would otherwise be," he said.

In its letter to shareholders, Netflix said it is getting more selective in the shows it licenses from studios. It will not renew a licensing deal that expires at the end of May for programming from Viacom Inc.'s networks including Nickelodeon, MTV and BET. Netflix said the companies are in discussions about a new deal that could involve particular shows. A Viacom spokesman said, "We are in discussion with several parties, including Netflix, on distribution of our content."

A more selective licensing strategy could affect major entertainment companies, which in the past couple of years have enjoyed extra revenue provided by Netflix's licensing deals. But questions have also been raised about the impact on traditional TV ratings. Viacom, in particular, has seen ratings at its Nickelodeon channel fall since Nickelodeon shows began appearing on Netflix in 2011. Viacom, though, has played down the impact of Netflix, noting that TV ratings don't reflect viewing on tablets and other mobile devices. Viacom has also noted that Nickelodeon's ratings have begun to improve.

The international-streaming unit is a source of future growth but has been a drag on profitability, with $389 million in losses last year and another $77 million in the first quarter. That is an improvement over the $103 million loss in the year-earlier period. The company added one million international streaming users in the quarter, bringing its total to 7.1 million.

Netflix said it is improving profits or reducing losses in all international markets. It didn't launch any major new markets in the first quarter and has said it doesn't plan to until at least the second half of the year.

The DVD-by-mail business continued to shrink, losing 240,000 subscribers in the quarter to 7.98 million.

Netflix raised $500 million in February through a bond offering. About $225 million of the proceeds went to refinance existing debt, with the rest going toward corporate purposes as the company expands.

Netflix also unveiled a new $11.99 per month plan in the U.S. that will allow users to simultaneously stream four videos. The company currently limits playing two video streams simultaneously. Netflix expects fewer than 1% of its subscribers to take it.

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